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As the Dodd-Frank financial reform law nears its two-year anniversary Saturday, one of the last big lobbying fights over the landmark measure is unfolding over underwriting standards.
A rule expected by year’s end will require lenders to judge whether borrowers can repay home loans as part of efforts to discourage risky lending and restore trust in the mortgage market. A key question is how to shield the lenders from lawsuits if borrowers still default.
A bipartisan group of 108 Members of Congress, led by Reps. Shelley Moore Capito (R-W.Va.) and Brad Sherman (D-Calif.), is pressing regulators to include a “safe harbor” provision in the rule that could protect bankers from claims that they didn’t adequately assess borrowers’ ability to repay.
Groups that include the Mortgage Bankers Association, the American Bankers Association, the National Association of Realtors and the National Association of Home Builders say that without the provision, lenders might stop making loans, tighten credit or raise interest rates to offset the threat of more litigation, shutting out some middle- and working-class homebuyers.
“It’s the most impactful rule on who will gain access to home ownership over the long term,” said David Stevens, president and CEO of the MBA and a former assistant housing secretary in the Obama administration.
Stevens and other banking and real estate executives said limiting legal liability will reduce lending costs to consumers and spur more competition in the mortgage marketplace. As many as 20 percent of potential homebuyers who could adequately carry debt are unable to get loans because of tight lending practices or high borrowing costs, according to some administration estimates.
Consumer groups, however, say the industry concerns over litigation are overblown, adding that the safe harbor language could open the door to the kind of predatory lending that hastened the financial crisis that began in 2007 and expose consumers to unnecessary risks.
“If the rules don’t follow the intent of the law, it’s as if the law wasn’t written in the first place,” said Alys Cohen, staff attorney for the National Consumer Law Center. “The fact there’s still so much discussion about changing the statute is unfortunate.”
The battle shows how much lobbying might continue to be thrown at details of a landmark law that was enacted two years ago. The Dodd-Frank reforms, named for its sponsors, former Sen. Chris Dodd (D-Conn.)and Rep. Barney Frank (D-Mass.), altered banking and securities laws going as far back as the 1930s. Among other things, the law set new federal rules for home loans and created a consumer protection agency, the Consumer Financial Protection Bureau.
The Federal Reserve originally proposed the lending standards, known as the “qualified mortgage” rule, last year before transferring the job to the CFPB, which has until January to issue a final version. Lobbyists expect the rule to be issued after the presidential election.
The Federal Reserve proposed two options for legally shielding lenders. One was the safe harbor, which protects banks that follow guidelines for verifying borrowers’ ability to repay against suits that try to hold them liable for defaults. The second was a “rebuttable presumption” that assumes loans comply with the law but gives consumers the ability to sue based on other facts or evidence.
The CFPB’s decision will not only affect what kind of mortgages are offered but also lenders’ ability to resell the loans to Wall Street. Banks and other institutions that buy mortgage-backed securities might demand higher rates of return to account for unexpected liabilities, according to the Securities Industry and Financial Markets Association, which backs the safe harbor.
Capito, Sherman and the other lawmakers say the rebuttable presumption doesn’t give lenders enough legal certainty.
Congress “recognized the need to ensure that properly underwritten loans are not weighted down by this additional liability” when it wrote the law, the Members wrote in a July 12 letter to CFPB Director Richard Cordray. A presumption of compliance gives lenders little incentive to write qualified mortgages, the lawmakers wrote.
Capito is chairwoman of the House Financial Services Subcommittee on Financial Institutions and Consumer Credit, which has been holding a series of hearings on the effects of Dodd-Frank.
The CFPB doesn’t have to follow the lawmakers’ recommendations. Cordray earlier this year told the House Financial Services Committee his agency is aware of the importance of creating bright lines in the rule to avoid litigation.
Stevens, of the MBA, said the Members’ appeal reflects deep-seated concern over who will get access to home ownership. But the Consumer Law Center’s Cohen said regulators will always be several steps behind the market, underscoring the need for a rule that provides a backstop to reckless lending.
“Even if we say loans should be affordable, loans will be made that are unaffordable,” Cohen said. “We don’t know what the next wave of abuse will look like.”